8.6. Royal Birkdale Company is interested in buying an apartment and renting it

Question

8.6. Royal Birkdale Company is interested in buying an apartment and renting it out for $12,000 a year, collecting the rent in advance each year. Royal Birkdale will depreciate the apartment over 20 years, but sell it after 5 years at a price, which is 20% more than its purchase price. The maintenance expenses and real estate taxes, paid at the end of each year, are $2000 annually. The after tax cost of capital for Royal Birkdale is 10%, and its income tax rate is 25%. Find the price of the apartment that Royal Birkdale should pay so that it can make $10,000 in current dollars from this project.

PLEASE SHOW SOLUTIONS.

Explanation / Answer

Let the price of the apartment be X Rental Income per year 12000 Maintenance Expenses and Real Estate Taxes paid -2000 10000 Income Tax impact @ 25% -2500 Net Income per year 7500 Cost of Capital or Discounted Rate 10% Sale Price of Apartment = 1.20 X Net Present Value to be earned from project = 10,000 Given these factors, X will be worked out using the Net Present Value formula Based on the formula, the price of the apartment which Royal Birkdale Company has to pay so that it can make $ 10,000 in current dollars from the project is $ 54,025. NPV using this cost = 10,000.68

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